Why 2016 has been a terrible year for tech IPOs

Only 11 U.S. companies have gone public in 2016, making it the worst start to a year for initial public offerings since 2009, when only four companies made it out of the gate by April 20.

At this time last year, 43 companies had gone public, according to Renaissance Capital, which runs IPO-focused exchange traded funds.

This year’s crop includes 9 biotech companies and two financial firms. But several of the biotech deals were “quasi IPOs,” because almost half or more of their newly issued stock was purchased by existing investors, said Kathleen Smith, a principal with Renaissance.

The last technology company to go public was Atlassian, an Australian software maker, on Dec. 10.

You can’t blame the overall market for the IPO window all but closing shut. After a scary sell-off in January, the Standard & Poor’s 500 index is up almost 3 percent this year and is within 1.3 percent of its all-time high.

You could blame the performance of recent IPOs, however. The Renaissance IPO exchange traded fund, which tracks an index of recent IPOs, is down 8 percent year to date.

The last technology company to go public was software maker Atlassian on Dec. 10.

Photo: Leah Millis Leah Millis, The Chronicle

“Investors aren’t going to jump into an IPO if existing ones are down,” Smith said.

Some are hoping that Bats Global Markets will crack open the IPO market. Last Thursday, the stock-exchange operator priced its shares at $19 and increased the size of its IPO. It closed Wednesday at $23.

Three notable deals this week could further open the window. MGM Growth Properties, a real estate investment trust for casino resorts, priced its shares late Tuesday at $21, the high end of its range. It closed Wednesday at $22.01.

American Renal Associates Holdings, which operates dialysis centers, priced its IPO Wednesday at $22 per share and will begin trading Thursday.

SecureWorks is expected to become the year’s first tech IPO when it prices on Thursday. The cybersecurity company is being spun off by Dell, so it’s not a true test of venture-backed tech deals. But it will be closely watched by investors.

“Hundreds of companies want to go public. They want to see how these companies do first,” Smith said.

One reason the “works are kind of gummed up” is that valuations in the private market have outpaced public-market valuations, Smith said.

That means some companies would have to go public at a price lower than what their late-stage investors paid. Many of these investors get protections that compensate them if that happens, but that dilutes other investors.

“The private market spiked because you had all these nontraditional investors — hedge funds and mutual funds — investing in private companies,” said Michael Greeley, general partner with Flare Capital Partners, a venture investor in health care technology. “Now they are backing away.”

Some of the fund companies have written down the value of their investments in private tech firms and are pulling back on new investments. Blackrock, for example, invested in eight private companies in 2014 and six in 2015, but none in the most recent two quarters.

Yet the median valuation of private companies getting venture financing continued to climb into the first quarter of this year, except for those receiving series B financing, according to a report from Pitchbook.

A separate survey of 135 deals from the Cooley law firm showed these so-called pre-money valuations increased in both Series A and C transactions during the first quarter, while declining in Series B and D deals.

“We saw a slight increase in recapitalization transactions (in the first quarter), where companies say, ‘We are not going to make it.’ New investors come in and have to clean house,” said Cooley partner Craig Jacoby.

While it’s not unusual for the IPO market to close periodically, if it goes on too long it can have repercussions.

To pay off their investors, venture capital firms need the companies they invest in to go public or get acquired. But when private market valuations exceed those in the public market, the public companies that generally buy startups cannot justify paying those inflated prices, any more than IPO investors can, Jacoby explained.

Startups also need to get acquired or go public so their employees can cash in the stock part of their compensation and diversify their assets, although some companies provide limited ways employees can cash in while the firms are still private.

There is also a recycling effect that takes place when investors cash in their profits and invest in new startups.

“I think we all benefit from a predictable capital market system. If any one link is broken, the dollars can’t get recycled,” Greeley said.

Kathleen Pender writes the Net Worth column in The San Francisco Chronicle. She explains how the big business and economic news of the day affect a household's net worth. She covers saving, investing, debt, taxes, housing, mortgages, retirement plans, employment and unemployment with a focus on issues specific to California and the Bay Area.

When it comes to big financial decisions, she believes that the simplest answer is almost always the best and that people would stay out of money trouble if they didn't get involved in things they can't understand. Pender welcomes questions from readers and frequently answers them in her column.

She majored in business journalism at the University of Missouri-Columbia and was a Knight-Bagehot fellow in business journalism at Columbia University.